Omicron continues to cause volatility
V for Volatility continues to be the biggest winner in December as financial markets continue to scamper between the baseline and the net in a never-ending game of headline chasing tennis. Last night a combination of data confirming omicron is 4x more contagious than delta, and Fitch declaring Evergrande and Kaisa were in selective default, was enough to see the tail-chasing FOMO herd take risk off the table. The US dollar rose, US yields fell, Asian currencies crumbled, oil fell as did equities. You can tell it’s a FOMO herd move, as the Dow Jones was almost unchanged, while the growth gnomes sent the Nasdaq tumbling 1.71% lower.
A massive debt restructuring exercise now beckons for China’s more highly leveraged property developers, raising fears that China’s growth will take a dip next year. That will be enough to keep Asian currencies and regional stock markets nervous, although the new “risk management” committee at Evergrande suggests the government is already behind-the-scenes disembowelment process has begun. The main risk point here, for now, will be if the selective default by Fitch triggers cross-defaults on other debt resulting in immediate calls for payment. Bondholders, especially offshore ones, may leave the gun on safety. Although the PBOC has quite clearly said Evergrande will be resolved on commercial terms, the involvement of the government means immediate payment demands and asset seizures within China are off the table through the courts.
China has further muddied the waters today with the yuan. Yesterday, it set a noticeably weaker fixing, applying its highest “counter-cyclical” factor in many months. It has also hiked the amount of foreign currency reserves Chinese banks must hold. Today, with the subtlety of a sledgehammer falling towards some terrified walnuts, the PBOC set the USD/CNY fix at 6.3702, some 250 points higher than markets forecasts of 6.3449.
With China’s energy crunch easing, imported inflation fears, and despite some denials, fears that the property developer implosion could derail 2022 growth, China has clearly called time on further yuan strength. Offshore USD/CNH shot higher overnight, and onshore USD/CNY did the same this morning. China’s denials of currency manipulation will probably ring hollow with the United States in this day and age. The spectre of heightened trade tensions between the two, and the sense that China has blinked on growth risks, is as good a reason for Asian currencies and equities to be weak as any.
Tonight, we also have US Inflation data which could show YoY inflation for November hitting 7.0%. Baseline effects will ease that number through 2022 (we hope), and if you asked me yesterday, I would have said that a 7.0% print is priced in, as is a faster taper from the FOMC next week, with signals of earlier rate hikes. But with markets still chasing their tails back and forth on omicron headlines and now China headlines, I mean who is seriously surprised after this time that Evergrande is solvent? I am starting to feel that markets are complacent. This lack of conviction price action is very indicative of market inflexion points in my experience. US equities rose through the delta variant, but are trading noisily sideways through omicron, and with much higher day-to-day volatility. Don’t write off big moves lower by equities, and a sharp rise in US yields and the US dollar just yet. All roads still lead to the FOMC.
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